Wednesday, February 22, 2012

Cautiously Optimistic: Global Markets and Uncertainty

A recent article in The Economist from February 11 entitled “Not quite party time” discusses financial markets and recent optimism amidst signs of recovery. The article points out that MSCI index of global stocks is up by more than 7% since the start of the year. MSCI are indices that “provide exhaustive equity market coverage for over 70 countries (msci.com).” However, the article writes about “strangely little nervousness” in the atmosphere despite the threat of a Greek sovereign default. Nonetheless, some of the signs of recovery mentioned in the article are bond yields in in Spain and Italy, much mentioned in the Euro Crisis, having fallen to their lowest levels in three months.

Some of other the better than expected news was US unemployment for January coming in lower than predicted. Also the manufacturing and service sectors are beginning to rise. Across the Atlantic, the European Central Bank introduced a massive provision of three year liquidity to the region’s bank which calmed fears a collapse of a big Euro bank or failed bond auction. There has also been much applaud from the market to the action of central bankers who have “doubled down their commitment to cheap money.” In the US the Fed announced it was not going to raise interest rates while the Bank of England is presumed to continue bond buying. However, the article emphasize some caution, citing how least year there were expectations of accelerated growth for the US which instead went into a slump, in part because oil price spikes, the Arab spring and the Japanese earthquake.

Despite positives signs, I agree with the article that it is too soon to celebrate. The US is at the center of some potentially disruptive news. At the end of February politicians will have to decide whether to extend payroll-tax cuts and unemployment insurance with the consequence of dampening growth if they fail to reach an agreement. Further down the road, the Bush tax cuts expire December 31st which calls for automatic spending cuts. The combined effects of both these acts “would amount to fiscal tightening of almost 4% GDP, more than enough to drag the economy down again.” And as always the need to address the budget deficit looms over head.

There will also be presidential election this year and politicians are generally unwilling to implement any type of monetary or fiscal tightening in the lead up to an election. Most famously Richard Nixon was willing to go as far as abandoning the gold standard with the dollar to prevent the domestic adjustments necessary for maintain a fixed exchange rate, in order to defeat JFK in the 1972 presidential election. For this reason I would expect something to get passed on extending unemployment benefits, which helps politicians build support, but nothing substantive with regard to budget deficits or the Bush tax cuts. Not to be ignored, the ECB’s success at calming worries of a recession has “reinforced Germany’s conviction that its preferred solution to solving the single currency’s underlying problems—namely, a hefty dose of austerity for all—is the right one.” The Germans see the Euro crisis as a morality play. They worked hard, saved and acted responsibly while countries on the periphery acted profligate. At the same time Germany is one of the most ardent supports of the EU and won’t let it fail, but that doesn’t mean those on the periphery won’t feel pain. The problem with austerity is that it hurts growth at a time when growth is what Europe needs.

Even unemployment figures in the US can be misleading with discouraged workers leaving the labor force and unemployment still much higher for minorities, which can signal still more domestic unrest. Even in Europe, I worry that if Germany gets its way we may see more stagnant growth. The Iran situation has the potential to become an Iran problem which could have repercussions for oil prices. In time of temporary optimism I wonder if shorting stocks makes sense.

Much of the optimism is based on US politicians and their ability to choose the right policies. Central bankers have down their part and now the ball is the court of policy makers. However, I find US politics to be unstable and the prospects of a democratic president, assuming Obama is re-elected, and republic congress make it less likely anything of substance will be enacted. Anyone who wants to start celebrating that we are almost out of the woods may want to keep the champagne on ice for a little longer.

About Me

Global Economic Team (GET) was started Fall of 2010 and consists of University of Oregon students who belong to the International Business and Economics Club (IBEC). The main focus is to discuss, analyze, and share knowledge of international trade and economics.
We are currently focusing on the currency trading market and the relations that current events may have on certain foreign exchange trends.